Economics Modeling
Macroeconomic Models are part of the IB Syllabus for macroeconomics as well as the syllabus for AP Macroeconomics for National Income and Price Determination Aggregate Supply Short run aggregate supply is the supply of all finished goods and services within an economy at a given price level. The aggregate supply curve describes the relationship between price levels and the quantity of output that firms are willing to provide. The curve is upward sloping. Long run aggregate supply is the vertical line at the level of Natural Real GDP or Full Employment level of National Income. It shows the output the economy produces when wages and prices have adjusted to their final equilibrium levels and neither the producers or workers have any misperceptions. It is the "ideal" state of the economy - i.e., it is the level of output that would occur if all resources were used to their full potential. This is why LRAS is vertical - real GDP (x-axis) is independent of the Price Level (y-axis). There are two views in economics: the Classical & Neo-classical and the Keynesian views. Prior to the 1930's, economists viewed the cycle of money and markets from a Neo-classical point of view. Neo-classical '''economists view the LRAS curve as being perfectly inelastic at a level of output where actual GDP has achieved its potential. Real GDP will always return to the level where all available labor resources find employment. Neo-classical approach to Aggregate Supply is modeled in Figure A. Figure A In the '''Keynesian view, the Aggregate Supply curve consists of two segments. One of them is completely horizontal, indicating that there is a decrease in Real Output as the demand declines because prices remain constant. The other segment is completely vertical, indicating that Full Employment is sustainable at higher price levels. The Keynesian view is modeled in Figure B. Figure B Full Employment Level of National Income Full employment level of National Income means the level of GDP attained when unemployment is at zero cyclical. This means that no one is unemployed due to cyclical changes in the economy (i.e... recessions or inflationary gaps). The full employment level is when an economy is operating with only Seasonal, Frictional, and Structural unemployment. These three types of unemployment are called "natural" unemployment, and a healthy economy operating at Full Employment always has 2-3% unemployment due to the natural rate of unemployment. Equilibrium Level of National Income Inflationary and Deflationary Gaps Inflationary Gap- The amount by which the real GDP (Gross Domestic Product) exceeds potential GDP. When the equilibrium between SRAS and AD is to the right of LRAS. Deflationary (Rescessionary) Gap- The condition where the Real GDP the economy is producing is less than the Natural Real GDP and the unemployment rate is greater than the natural unemployment rate. In a Deflationary gap there are too few workers working for too high of a wage. The blue portion shows the deflation. The company has to fire workers, or lower wages to return back to equilibrium. Most companies will lower wages, which causes SRAS to shift right. As the price level falls, real balance, interest rate and international trade effects increase the quantity demanded of Real GDP. The economy is now at equilibrium point two. Business Cycle The business cycle follows a loop trend. Growth in a country steadily increases with time, but at a closer look, the economy falls into recessions, recovers, and moves to peaks or inflation. The Business Cycle supports the Neo-Classical approach to the economy that says if a free market economy is left to it's own devices, it will naturally have ups and downs and will always correct itself with time back to LRAS and the full employment level of the economy. In the Business Cycle, if a country don't do anything to get out of an inflation or recession, then the automatic stablizers would work instantionally but for the discretionary, then it'll take the process very long to get out of the situation. Components of Aggregate Demand (AD) AD will shift to the right, or increase, if any of these occur : Consumption increases- Perceived wealth, or the money people believe they have, increases Inflation is expected to increase Interest Rates decrease Personal taxes decrease Expected income increases Investment increases- Future sales in a company are expected to increase Interest rates decrease Business taxes decrease Net Exports (imports subtracted from exports) increase- Foreign prices increase, making our goods seem cheaper by comparison Foreigners get richer, so our goods seem less expensive Currency value decreases Government Spending increases'-' If any of these occur, AD will shift to the right. If the opposite of these occurs, AD will shift to the left, or decrease. Category:Macroeconomics